Decoding Nigeria’s Tax Code: A Comprehensive Guide to Capital Allowances, VAT Compliance, and Business Structures

Decoding Nigeria’s Tax Code: A Comprehensive Guide to Capital Allowances, VAT Compliance, and Business Structures

The Nigerian tax landscape is characterized by deeply specialized regulations, particularly within key sectors and across crucial compliance frameworks. Bahas Books presents a comprehensive breakdown of the statutory rules governing Capital Allowances for petroleum operations, the intricate mandates for Value Added Tax (VAT) compliance, the defined assessment rules for business commencement and cessation, and a critical examination of business structures and tax administration. Navigating these areas is fundamental to ensuring accurate tax compliance and strategic financial management in Nigeria.

I. Capital Allowances for Petroleum Operations (Nigeria Tax Act, 2025)

Part III - Capital Allowance for Petroleum Operations of the Nigeria Tax Act, 2025, establishes the precise legal mechanism allowing companies subject to Petroleum Profits Tax and those operating under Deep Offshore and Inland Basin Production Sharing Contracts to recover their qualifying capital expenditure.

Definitions and Exclusion from Qualifying Expenditure

The law provides essential definitions to ensure clarity. A "concession" is defined broadly to include an oil exploration license, an oil prospecting license, an oil mining lease, any right, title, or interest in or over petroleum oil, and any option to acquire such rights. The term "lease" encompasses agreements for a lease where the term has commenced, any tenancy, and any agreement for letting or hiring an asset, but it explicitly excludes a mortgage. To maintain continuity, the law deems a lease to continue if the lessee remains in possession after its termination without a new grant, and a new lease granted to the same party upon the termination of an old one is treated as a continuation of the first lease.

The central concept is "qualifying expenditure," which is capital expenditure incurred in an accounting period and is grouped into four specific categories: Qualifying Plant Expenditure (on plant, machinery, and fixtures); Qualifying Pipeline and Storage Expenditure (on pipelines and storage tanks); Qualifying Building Expenditure (on permanent buildings, structures, or works not covered in the first two categories); and Qualifying Drilling Expenditure (all other capital expenditure for petroleum operations, which includes costs for acquiring deposits/rights, searching for, discovering or testing deposits, and constructing works or buildings likely to have little or no residual value when operations cease). Importantly, certain expenditures are excluded from qualifying expenditure: any amount deductible under section 92 of the Act, expenditure allowed as a deduction under any other provision of the Act, or expenditure on an ocean-going oil tanker plying between Nigeria and any other territory.

For timing purposes, Pre-commencement expenditure incurred before a company's first accounting period is deemed to be incurred on the first day of its first accounting period. If an asset is disposed of before the first accounting period begins, any resulting loss incurred is deemed to be qualifying petroleum expenditure incurred on that first day, while any profit realised is treated as income of the company in its first accounting period.

Allowance Structure, Rates, and Asset Status

The law grants two distinct allowances for expenditure incurred wholly and exclusively for petroleum operations: Petroleum Investment Allowance (Table I) and Standard Capital Allowance (Table II).

The Petroleum Investment Allowance is an additional allowance, granted only in the accounting period when the asset is first used. The rate for this allowance is graduated based on the water depth of operations: 5% for Onshore operations, 10% for operations up to and including 100 metres of water depth, and 15% for operations between 100 and 200 metres of water depth.

The Standard Capital Allowance (Table II) is available from the period the expenditure was incurred. The rate is a uniform 20% for each of the 1st, 2nd, 3rd, 4th, and 5th years for all four categories of qualifying expenditure. A notional 1% of the qualifying expenditure must be recorded for statistical purposes, but this amount shall not increase or reduce the amount of capital allowance claimable. For Exploration expenditure, the cost of the first and second appraisal wells in the same field are treated as a 100% deductible expense in the year incurred. An asset is deemed "in use" even during a period of temporary disuse. However, if an allowance has been granted and the asset is not put to use within five years from the date the expenditure was incurred, the previous allowance claimed shall be withdrawn and added back to tax. The Residue of an asset is defined as the total qualifying expenditure less the total capital allowance made to date.

Disposal and Apportionment Rules

In cases of disposal of an asset without change of ownership where the owner retains ownership, the owner is deemed to have bought the asset back immediately for a price equal to the residue at the date of disposal. Disposal of any asset in respect of which capital allowance has been granted requires a Certificate of Disposal issued by the Commission. The Value of an asset at disposal is its net proceeds of sale or the open market value estimated by the Service, less selling expenses. Insurance or compensation monies are treated as net proceeds, unless they are used for the replacement of the lost asset.

For Apportionment, if a qualifying asset is disposed of or purchased together with a non-qualifying asset, the Service shall attribute a just and reasonable proportion of the value to the qualifying asset. Similarly, if an asset is used partly for petroleum operations and partly for other purposes, the allowance shall be computed as if it were used wholly and exclusively for upstream crude oil operations, and the resulting allowance must be treated as just and reasonable by the Service.

II. Detailed Rules for Value Added Tax (VAT) Compliance

The VAT framework establishes definitive rules regarding responsibility, collection methods, calculation, and the exact timing and location of a taxable supply. A taxable supply refers to goods and services that should be taxed.

VAT Responsibility, Collection, and Non-Resident Obligations

The responsibility for charging and collecting VAT rests with all taxable persons engaged in taxable supplies, with the explicit exception of small businesses. VAT collection can occur in three distinct ways: during the supply of the taxable goods; by being withheld at source by an appointed tax authority representative; or through a self-account system where the recipient remits the tax. Computationally, Input VAT is the tax paid on purchased goods, services, or fixed assets, while Output VAT is the tax charged on taxable supplies made. VAT Payable is computed as VAT Output minus VAT Input, and VAT Credit is the excess VAT that the company is entitled to claim.

Non-resident persons making taxable supplies to Nigeria face mandatory compliance. They are mandated to register for tax and charge VAT. However, if the supplies are made from outside the country, the taxable person who received the supply is required to withhold the VAT and remit it to the relevant tax authority. The non-resident person may also appoint a representative for the purpose of VAT compliance in Nigeria.

Time, Value, and Location of Taxable Supplies

A taxable supply is deemed to have taken place when any of the following occurs first: at the time an invoice or receipt is issued by the supplier; where goods are delivered or made available for use; or when payment is due to or received by the supplier in respect of that supply.

Specific timing rules apply: for goods sold on credit, supply is deemed to take place at the earlier of when the taxable supply is delivered or when payment is received by the supplier. For rental or periodic supplies or services which people use and pay periodically, supply is deemed to take place for each period when payment is due or is received by the supplier, whichever is earlier. For periodic payments or installments, VAT is charged once payment is due, received, or an invoice is issued, whichever comes first. This rule also applies to payments for a project made in relation to the progressive nature of the project. For supply between connected persons where invoices are not issued: if goods are to be removed, the time of supply is the moment of removing the goods; if not to be removed, it is once they are available to the recipient; for a service, it is fixed upon commencement; and for incorporeal supplies (intangible assets like trademarks, business names, or franchises), it is when the asset becomes available for the use of the recipient.

The Value of Taxable Supplies for a money consideration is defined as the Price plus VAT, meaning VAT will be calculated and charged on the price of the goods. Rules for the valuation of taxable supplies with non-money consideration are also provided for.

Goods are supplied in Nigeria if: the goods are physically present, imported into, assembled, or installed in Nigeria at the time of supply. Goods are also deemed supplied in Nigeria if the beneficial owner of the rights in or over the goods is a taxable person in Nigeria and the goods or right is situated, registered, or exercisable in Nigeria. Services are supplied in Nigeria if: the service is provided to or consumed by someone in Nigeria, regardless of where the service is rendered or whether the obligation to render the service rests upon a person within or outside Nigeria. Services are also supplied in Nigeria if they are connected with existing immovable property (including the services of agents, experts, engineers, architects, and valuers), where the property is located in Nigeria.

VAT Invoice Requirements

A taxable person who makes a taxable supply shall maintain a sequential invoice numbering system. A VAT Invoice must be issued on supply whether or not payment is made at the time of supply. The mandatory content of a VAT invoice includes: the supplier's tax ID; a unique invoice number; the name and address of the supplier; the supplier's incorporation or business registration number as applicable; the date of supply; the name of the purchaser or client; the gross amount of the transaction; and the VAT charged and the rate applied.

III. Detailed Rules for Commencement and Cessation of Business

This section outlines the statutory periods for calculating assessable profits during the critical initial three years of a business’s life and the final tax obligations upon its permanent discontinuation or change in accounting date.

Commencement of Business

The determination of assessable profits for the first three years of a business’s operation follows a specific structure based on the accounting period:

  • First year (of assessment): The basis period runs from the date the business commences its operations up to the end of its first Accounting period.

  • Second year (of assessment): The basis period runs from the first day immediately after the first accounting period ended up to the end of the second accounting period.

  • Third year (of assessment): The basis period runs from the day after the last accounting period ended up to the final day of the Accounting year ended.

Cessation of Business and Change of Accounting Year End

When a trade, business, profession, or vocation permanently ceases to carry on its operations in Nigeria in a specific accounting period, the assessable profits for the relevant year of assessment shall be computed as the amount of the profits generated from the beginning of the last accounting period up to the actual date of cessation. The tax calculated on these final assessable profits shall be payable within six months from the date of cessation. If a taxable person changes the date to which it usually computes its assessable profits, the basis period for the computation of the assessable profits for the relevant year of assessment shall be the period commencing from the first day after the basis period of the immediately preceding year of assessment up to the new date on which the account was made. The assessable profits of subsequent years of assessments shall then be computed on the basis of the newly adopted accounting period.

IV. Tax Avoidance and Business Structure Differentiation

The provided information also addresses the legal distinction of Tax Avoidance, which is defined as the legal use of tax laws to reduce the amount of tax you are to pay. This includes strategies such as claiming deductions, choosing the right business structure, using tax reliefs and exemptions, and proper narration and categorisation of expenses.

Tax Administration Split

The Nigerian tax administration is split between the Nigeria Revenue Service (NRS) and the States Internal Revenue Service. The NRS is responsible for Company Income tax, Value Added tax, Withholding tax of companies, and Personal Income tax of specialised persons, such as the armed forces. The States Internal Revenue Service is responsible for Personal Income tax, Withholding tax of enterprise, and other state-approved revenue.

Enterprise vs. Limited Liability Company (LLC)

The distinction between an Enterprise and a Limited Liability Company (LLC) is critical for tax and compliance purposes.

An Enterprise does not pay income tax as an entity; the owner is taxed as an individual. It is subjected to VAT and WHT but has no requirement for an audited financial statement. The NRS is primarily interested in the enterprise's revenue for VAT and not its profit, often leading to less tax liability overall.

In contrast, an LLC pays Company Income tax, except for small companies. The owners/directors also pay personal income tax. An LLC is subjected to VAT and WHT, requires an audited financial statement, is answerable to both FIRS and NRS for both PIT and CIT, and generally incurs a higher compliance cost. An LLC is considered more structured, and the entity must still file returns even if exempted from tax.

When considering a change or registration as an LLC, a key caution is that it offers many business benefits, but not necessarily a tax benefit. Factors to consider include the nature of the business, its intention, and public perception. Advice for choosing includes: don't upgrade if your only reason is tax; don't upgrade if you can't afford structured accounting or the cost of an agent; upgrade if your business is big or needs other benefits of an LLC.

For further clarity on these complex tax provisions, consult the experts at bahasbooks.com.

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